Making the Most of Your Estate Plan: A Year-End Review

As 2010 quickly approaches, it is important to remember that there are many federal and state income, estate, gift and generation-skipping transfer tax laws that may have a direct impact on you. Therefore, now is a good time to engage in a year-end review of your estate plan, with special consideration of the following:

Annual Exclusion Gifts

One of the most powerful estate planning techniques is also one of the simplest. For 2010, individuals can make an unlimited number of gifts of up to $13,000 per recipient, per year. Over a period of time, this can result in substantial transfer tax savings (as both the gift itself and its income and growth are removed from the donor's estate), without paying gift tax or using any lifetime gift exemption (discussed below). Gifts made earlier in the year are generally more beneficial, as the income and appreciation inure to the benefit of the donee, rather than the donor. However, if annual exclusion gifts are not made by the end of the year, that year's exclusions will be lost.

Tuition and Medical Gifts

Additional unlimited gifts can still be made by paying tuition costs directly to the school or medical expenses directly to the health care provider (including the payment of health insurance premiums).

Federal and State Estate Tax Exemptions and Rates

In 2009, an individual may pass $3.5 million free of federal estate tax. Current law allows an unlimited amount to pass estate tax-free in 2010, and reduces the amount to $1 million in 2011. However, anticipated estate tax reform will likely extend the $3.5 million exemption to 2010. The federal government also imposes taxes at a flat 45% rate, which is not expected to change.

The federal government no longer shares the estate tax with the states. In a number of states, the federal and state estate tax exemptions have been decoupled such that different amounts can pass free of federal and state estate tax. For example, in 2009, even though the federal government allows you to pass $3.5 million estate tax-free, Illinois imposes its estate tax on taxable estates in excess of $2 million. While Illinois may have an approximate effective estate tax rate of up to 8% (after factoring in the federal deduction for state taxes), Arizona, California, Florida, Nevada and several other states currently have no estate tax. Now is an important time to review your estate planning documents in order to incorporate more flexible and tax-advantaged provisions to better address these estate tax issues.

Lifetime Gift Exemption

Although an individual can currently pass $3.5 million free of estate tax upon death, the same amount cannot be given away during lifetime without incurring a gift tax. The lifetime gift exemption remains at $1 million (in excess of the annual exclusion, tuition and medical gifts).

Generation-Skipping Transfer Tax Exemption

In order to ensure a death tax at each successive generational level, a generation-skipping transfer tax is imposed on transfers to grandchildren or more remote descendants at the top estate tax rate. However, the same amount that can pass free of estate tax ($3.5 million) can pass generation-skipping tax-free to grandchildren and more remote descendants.

Putting Your Exemptions to Use

The combination of recent volatility and depressed values in the financial markets and historically low interest rates has created an environment ripe for estate planning and transferring wealth to descendants on a tax-advantaged basis. As everyone knows, the economy moves in cycles. Hopefully, values will eventually increase again. When they do, the opportunity to reduce, or even eliminate, your transfer taxes on such favorable terms may be gone.

Assets whose values are "temporarily" depressed due to the current economic conditions but are expected to recover would be good targets for a giving program. Based on the current applicable laws, the increase in value when the economy recovers and the appreciation thereon would pass to the donees gift tax-free. The lower current applicable federal interest rates also make gifting through a grantor retained annuity trust (GRAT), a charitable lead trust (CLT), intra-family loans, and the "sale to grantor trust" technique even more beneficial.

Gifts in Trust

Despite the tax savings, many individuals are uneasy about making outright gifts to their descendants. Such concerns can usually be addressed by structuring the gifts in trust, which will allow you to determine how the assets will be used and when your descendants will receive the funds. The use of gift trusts can also provide the beneficiaries with a level of creditor protection (including protection from a divorcing spouse) and additional transfer tax leverage.

Prepare for Roth IRA Conversions

Beginning in 2010, anyone (regardless of income) is allowed to convert a regular IRA to a Roth IRA. Upon conversion, the entire converted amount is subject to income taxation at your current tax bracket. If you do the conversion in 2010, the rollover can either be reported in 2010, or spread out ratably in 2011 and 2012. Due to the market decline, you should be able to convert your regular IRA to a Roth IRA at a much lower cost than would have been possible when stock market values were high.

There are certain unique features of Roth IRAs that make them particularly attractive. Distributions, for example, are generally income tax-free. In addition, the required minimum distribution rules do not apply to Roth IRAs during your lifetime. You can also pass a Roth IRA to a younger generation, thus allowing it to continue growing income tax-free (although your beneficiaries will be required to take minimum distributions). Ultimately, converting a regular IRA to a Roth IRA will shrink the size of your taxable estate and the estate taxes that may be due thereon, and with careful estate planning, can foster decades of tax-free growth for these assets.

Required Minimum Distributions

Individuals over age 70.5 are generally required to take required minimum distributions from their retirement plans (other than Roth IRAs) each year. However, for 2009 the required minimum distributions were waived. There has also been talk in Congress to waive the required minimum distributions for 2010.

For More Information

These and other federal and state laws can have significant financial consequences for you and your family. We recommend that you speak to your Much Shelist attorney or contact a member of our Wealth Transfer & Succession Planning practice group to determine appropriate strategies that meet your objectives and address your circumstances.

Circular 230 Notice. To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.